The monetary authority is proposing a global regulatory framework to mitigate the risks of financial stability from crypto and its increasing adoption.
In a blog post published on Tuesday, the International Monetary Fund (IMF) wrote that as the crypto markets grow, the correlation between crypto currencies and the financial markets increases accordingly.
The coronavirus pandemic has redefined correlations in the investment landscape
Before COVID-19, the IMF stated, there was little relationship between crypto assets like Bitcoin and stocks. As such, they were considered good options for investors to hedge against inflation.
Over time, however, the pandemic pushed financial systems to their limits, prompting the central bank to take steps to ease the burden. As a result, both crypto prices and the US stock market skyrocketed due to the favorable financial environment and the increased risk appetite of investors.
An example of the impact of banks' reactions is the correlation coefficient between Bitcoin returns and the S&P 500, which rose to 0.36 over the 2020-2021 period. Between 2017 and 2019, this value remained unchanged at 0.01
“For example, Bitcoin returns did not move in any particular direction in 2017-19 with the S&P 500, the benchmark stock index for the United States. The correlation coefficient of their daily movements was only 0.01, but that measure rose to 0.36 for 2020-21 as assets moved more in lockstep, rising or falling together, " the post said.
The IMF pointed out that similar correlation behavior had been observed in the stock market and in stablecoins.
The monetary authority stated that the overlap between crypto and stock markets was primarily due to cases of market volatility or sharp fluctuations in the price of Bitcoin. The panel concluded that Bitcoin was acting as a high risk asset and noted that its co-movement with stocks has outperformed that between stocks and alternative assets like gold.
Regulations to contain the systemic threats
The post also pointed to a previously published proposal for a framework that provides guidelines for implementing global cryptocurrency regulations. The proposal recommends, among other things, that crypto service providers must obtain the approval of the competent authorities in order to create a level playing field.
The IMF also noted that such a framework would be critical to addressing the financial stability risks posed by the crypto scene as cryptocurrencies become more prevalent in the mainstream arena. In addition, he recommended that the regulations address key cryptocurrency use cases and the relationship between financial institutions and crypto assets, as well as put in place monitoring systems for the crypto ecosystem.
However, the organization stressed that when implementing new regulations, care should be taken not to stall innovation in this sector.
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